Why central banks have taken digital currency seriously

1. What would central bank digital currency look like?

It’s not that different, at least on the surface, from keeping e-money in a bank account and using cards, smartphones, or apps to send that bank money out into the world. The main difference is that central bank-provided money – like cash – is a risk-free asset. For example, a physical dollar bill is always worth one dollar. A dollar in a commercial bank account, although in theory convertible into paper currency on demand, is subject to the solvency and liquidity risks of that bank, which means that consumers may not always be able to access it, or might even lose it on rare occasions. CBDCs, like banknotes and coins, would be the direct responsibility of the central bank.

2. How would this change payouts?

CBDCs could come in many forms, but one of them would be to speed up payments. Under the current system, commercial banks settle their net payments with each other using central bank money, but this process is generally not instantaneous for technological and operational reasons, and therefore opens up credit risk during the term of the regulation.

3. What does this have to do with cryptocurrencies?

Aside from the potential tech design, not much else. CBDCs are conceptually different from a cryptocurrency like Bitcoin, which is too volatile to be a store of value and insufficiently accepted to be useful for payments. Bitcoin is more in the realm of a speculative asset. A key appeal among Bitcoin proponents is its decentralization, meaning there is no central party controlling it, with transactions recorded on a publicly distributed ledger. CBDCs are controlled by a central bank. While some countries are experimenting with full or partial use of distributed ledger technology, known as blockchain, for their CBDCs, it is uncertain whether they will eventually use it. The European Central Bank, for example, has expressed concern about the environmental footprint of operating parallel blockchain infrastructure and already has another system launched in 2018 that may be more suitable.

4. What are the different types of CBDCs?

There are two main channels: wholesale and retail. In retail projects, CBDCs would be issued through what would effectively be accounts at a central bank for the general public – or accounts at commercial banks working with the central bank. A CBDC-based system presents no credit risk: the funds do not appear on the balance sheet of an intermediary and the transactions are settled directly and instantly on the balance sheet of the central bank. A retail approach could be particularly useful for consumers who do not have access to traditional banking services. Some countries, such as Denmark, have ruled this out, however, as it could leave banks vulnerable to depositors who may flee to central bank accounts. Other central banks have said they will impose upper limits on holdings to prevent such risks to financial stability. In wholesale projects, access to digital currency would be limited to banks and other institutions to make payment flows within the existing financial system faster and cheaper, but with less disruption to the overall industry structure.

According to the IMF, about 100 countries are in various stages of exploring CBDCs. India surprised the payments world by announcing that its central bank would issue a digital rupee as early as next financial year, while China rolled out its digital yuan to athletes and spectators ahead of the Beijing Winter Olympics in 2022 to test its appeal to foreigners. Some of the Eastern Caribbean islands that share a central bank have already launched their own digital currency, DCash. This was extended to Saint Vincent and the Grenadines last year after a volcanic eruption forced thousands of people to be evacuated from their homes, and the deployment was seen as an important part of reconstruction efforts .

The Fed, for its part, has been slow to warm up to the idea of ​​a digital currency, but it recently took a key step by releasing a 35-page discussion paper in which it outlined a series of benefits. potentials. Still, he did not draw any firm conclusions about the prudence of issuing such currency and in any case said he would not proceed without the support of the White House and Congress. The Bank of Canada has yet to find an urgent case for a digital currency, but continues to build technical capacity to issue a CBDC and monitor developments that may increase its urgency.

7. What would be the benefits?

If central banks can overcome the technical difficulties, digital currencies could enable faster and cheaper money transfers within economies and across borders. They could also improve access to legal tender in countries where liquidity is diminishing. An IMF paper said the new currencies could boost financial inclusion in places where private financial institutions find it unprofitable to operate, and generate more resilience in regions prone to natural disasters. ECB President Christine Lagarde has argued that a digital euro could become particularly important amid rising protectionist policies if these lead to disruption of foreign-dominated European payment services. For China, a digital currency offers a possible way to track and control a rapidly digitizing economy. On the other hand, it could also give the government an additional oversight tool.

8. What are the other disadvantages?

The risks of being wrong are significant, which is why most central bankers have so far been cautious. Under the CBDC model, central banks risk either cutting out commercial banks, a vital source of finance for the real economy, or assuming the direct risks and complications of banking for the masses. Problems in running a business new to them could undermine the public trust they rely on to let them pursue sometimes unpopular actions like interest rate hikes. Additionally, some researchers have expressed doubts about the ability of current blockchain technology to support a large volume of concurrent transactions. A People’s Bank of China official said his research showed that Bitcoin’s blockchain capacity was well below peak demand, during the 2018 China Singles’ Day shopping gala, of 92,771 transactions. per second. Other studies have shown that Ethereum handles an average of 15 transactions per second, while Visa Inc.’s network can handle 24,000.